4 ETFs In The Crosshairs As Defense Cuts Loom — Is It Time To Play Offense?

The U.S. defense sector is facing fresh uncertainty as the Trump administration sets the foundation for a cost-cutting initiative under the newly established Department of Government Efficiency (DOGE). Despite the recent buoyancy in anticipation of peace talks involving the Presidents of the U.S., Russia and Ukraine, stocks of major defense contractors, including Lockheed Martin LMT, RTX Corp. RTX, General Dynamics GD, and Northrop Grumman NOC, are staring at near-term risks following the possibility of a defense budget cut.

While the potential impact is still unfolding, defense-focused ETFs could be in for a bumpy ride.

ETFs with significant holdings in defense giants may see volatility in the wake of potential budget constraints. Some of the key funds to monitor include:

iShares U.S. Aerospace & Defense ETF ITA – Tracks U.S. defense and aerospace companies, including General Dynamics (18.75% exposure) Lockheed Martin (4.98% exposure) and RTX (15.72% exposure).

SPDR S&P Aerospace & Defense ETF XAR – Offers exposure to large and mid-cap defense stocks, with exposure to stocks like Lockheed Martin, General Dynamics and RTX. This ETF offers a more equally weighted approach, which may help balance the losses.

Invesco Aerospace & Defense ETF PPA – Holds a diversified mix of defense contractors and related industries. However, Lockheed Martin and RTX hold the top positions, with 7.26% and 7% of the total AUM.

First Trust Indxx Aerospace & Defense ETF MISL – A newer entrant with a focus on companies involved in missile and defense technology. Once again, Lockheed Martin, General Dynamics and RTX hold significant percentage of the total assets.

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Why Defense Stocks Are Under Pressure

The DOGE recently kicked off its review at the Pentagon, aiming to curb waste, fraud, and redundancies. In a post on X, DOGE officials confirmed their commitment to "safely save taxpayer dollars and eliminate waste."

Great kickoff with @DeptofDefense.

Looking forward to working together to safely save taxpayer dollars and eliminate waste, fraud and abuse.

— Department of Government Efficiency (@DOGE) February 15, 2025

Defense Secretary Pete Hegseth echoed this sentiment, emphasizing the need to streamline operations and optimize spending, as reported by CBS News.

This initiative has raised concerns for major defense contractors, many of whom rely heavily on government contracts. Among the top players at risk are Lockheed Martin which has retreated almost 10% so far this year, RTX , General Dynamics, with a loss of 6.35% year-to-date, and Northrop Grumman, which has lost 6.5% so far this year.

With over $200 billion in annual federal contracts flowing into the sector, any cuts could significantly affect companies that derive nearly half their revenue from government spending, according to a report by Saxo Bank.

While U.S. defense spending may come under pressure, rising geopolitical tensions and commitments from NATO allies to boost their military budgets could create new opportunities for defense firms.

Fine-Tuning Is Key

For investors holding defense-heavy ETFs, now may be a time for caution but not necessarily panic. Watching how DOGE's review unfolds, tracking upcoming federal budgets, following the peace talks among Russia, Ukraine and U.S., and keeping an eye on global defense spending trends will be important. Diversification within ETFs could also help mitigate sector-specific risks.

As budget talks heat up, defense ETFs may experience short-term turbulence, but the longer-term picture will depend on how much of the spending shift is domestic versus international.

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